Chapter 8: Problem 29

Will a perfectly competitive market display allocative efficiency? Why or why not?

Short Answer

Expert verified

In a perfectly competitive market, allocative efficiency is achieved because the marginal cost of production (MC) is equal to the marginal benefit (MB), indicating that resources are properly allocated to maximize society's welfare. No more goods or services can be produced without increasing costs or reducing benefits, which shows that the market achieves allocative efficiency.

Step by step solution

Define Allocative Efficiency

Allocative efficiency occurs when the distribution of resources in an economy is such that no one can be made better off without making someone else worse off. In simpler terms, it means that the right amount of goods and services are being produced, which maximizes society's welfare.

Characteristics of a Perfectly Competitive Market

A perfectly competitive market is a type of market structure characterized by: 1. A large number of buyers and sellers, each acting independently. 2. Homogeneous products, meaning that the goods/services offered by different firms are identical. 3. Perfect information available, meaning that all consumers and producers have complete and accurate knowledge of the market. 4. No barriers to entry or exit, which ensures that firms can easily enter or exit the market.

Analyze the Market's Short-Run Equilibrium

In the short run, perfectly competitive markets reach an equilibrium point where the total quantity of goods and services demanded by consumers is equal to the total quantity supplied by firms. At this equilibrium point, the market price is determined by the intersection of the demand and supply curves.

Apply the Concept of Allocative Efficiency to a Perfectly Competitive Market

Allocative efficiency in a perfectly competitive market can be assessed by examining the relationship between the marginal cost (MC) and the marginal benefit (MB) of goods and services produced in the market. If MC = MB, then the market is allocatively efficient, as it indicates that resources are properly allocated and no more goods can be produced without increasing costs or reducing benefits. In a perfectly competitive market, price is equal to the marginal cost of production, which means that P = MC. Moreover, price is also equal to the marginal benefit, implying P = MB. Therefore, under perfect competition, MC = MB.

Conclusion

A perfectly competitive market will display allocative efficiency because the marginal cost of production (MC) is equal to the marginal benefit (MB) in the market. This indicates that resources are properly allocated to maximize society's welfare. No more goods or services can be produced without increasing costs or reducing benefits, implying that the market achieves allocative efficiency.